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THE LESSON TO BE LEARNED FROM SALOMON
Take a moment to reflect on the enormity of the disaster that Salomon Brothers has brought down on its own head. Its three top officers, one of them a giant on Wall Street, have left in disgrace. The firm's reputation has been sullied as revelations of its misbehavior multiply. And on Aug. 17, the Treasury Dept. banned the firm from bidding in its auctions (page 66).
The total blackballing lasted only a few hours. Salomon's largest shareholder, Omaha-based investor Warren Buffett, persuaded Treasury Secretary Nicholas Brady that Salomon could be mortally wounded by a complete ban. The firm was told it could bid, but only for its own account. Brady was wise to heed Buffett. Treasury bonds and bills are the basis for many of the sophisticated instruments--swaps, options, and futures--in which the firm is a leader worldwide. Protecting the integrity of the U. S. government-bond market does not require destroying a company that has an important competitive edge in world financial markets.
But the Treasury market must be kept honest beyond any doubt. That is why the New York Fed, which was handed the job of monitoring the auctions, demanded and got the resignations of Chairman John Gutfreund, Vice-Chairman John Meriwether, and President Thomas Strauss. The message should echo loud and clear up and down Wall Street: Nobody will be allowed to manipulate the price or have undue influence. Miscreants, the Fed told the Street, will be pursued and punished.
To guarantee the honesty of the Treasury market, Washington must also change the way it handles the sale of its debt. As things now stand, the rules of the government-bond game permit a dealer to buy 35% of any government bond issue, a proportion mbviously high enough to tempt any would-be market-rigger. The Fed has not been adequately sensitive to the failure of the 35% rule in the real world. The market had been buzzing for months with rumors of squeezes, including the one that occurred in the May, 1991, Treasury auction of two-year notes--rumors that BUSINESS WEEK heard and analyzed (BW--July 1). The 35% limit is far too high. Bring it down to 20% for any firm, as the Treasury has suggested in a trial balloon.
There is also evidence that the basic system that Washington uses to distribute government bonds is seriously flawed. Giving 40 firms, the primary dealers, the opportunity to glean special information in exchange for a pledge to bid for every government issue invites abuse. The primary-dealer system is a form of discrimination; the rules of the government-bond market must be changed to provide equal opportunity to all.
Washington set up government-bond auctions the way it did because it wanted an orderly, controlled market for government securities. But auctions that give special privileges to a government-sanctioned oligopoly were the locus of the Salomon disaster. The Treasury and the Fed can no longer be satisfied that they have created a ready market for the mountain of government debt. They must also ensure that the Treasury market is squeaky-clean.